A Message to the New NYCERS Chairperson

You have a huge problem. Your designated investment manager, the NYC Comptroller, is doing a terrible job with investing NYCERS assets, this Comptroller and the last three. NYCERS has an average annual rate of return over the last 15 years of 2.89%.

The Comptroller, however, has the backing of DC-37 which is the largest city union and also a NYCERS trustee. Between the three city unions on the NYCERS Board and the Comptroller these trustees control four votes, a majority of the total seven votes on the Board.

These votes control investment decisions, disability decisions, the NYCERS administrative budget and the budget subsidies from NYCERS to the Comptroller. The three unions are bound together because of disability votes at the Board. They need to back each other up to be able to get closely contested disability cases resolved in their favor.

Without the annual investment delegation from NYCERS Board of Trustees, the Comptroller has very little political influence. With the change in the City Charter in 1990 the mayor essentially controls the Comptroller’s administrative budget. This totally compromises his operating capabilities and his political influence.

If the Chair wishes to provide some relief to the mayor from the city’s huge pension burden, he will have to take away the Comptroller’s power over investment decisions.

This is a complicated task. Since 2005, DC-37 has run NYCERS as patronage mill for its flunkies. That starts with the executive director and spreads throughout the agency. This also includes regular employees who have criminal liabilities and are more than happy to do as they are told.

As the mayor’s appointee to the Board of Trustees, the Chair will need to take on both of these political entities. This will clearly be a hard fight. The investment issue cannot be resolved without addressing the investment delegation and the internal rot at NYCERS. The Chair will have to convince DC-37 that it is in its long term interest to reduce investment costs and raise returns. He will also have to commit to totally honest and sympathetic votes on disabilities that come before the Board of Trustees.

In return DC-37 and the other unions will have to not vote for the annual investment delegation to the Comptroller in June. It will also mean, however, that DC-37 will have to accept reform within NYCERS because the Comptroller will no longer have any incentive to allow NYCERS executive staff to run wild with the agency.

In eliminating the Comptroller from investment management operations the Board will have to hire a truly independent investment consultant and hire internal NYCERS staff to track investment activity. You can see why NYCERS also needs to be reformed. Current investment consultants under contract to NYCERS have structural conflict of interest issues involving the investment community. A large part of their revenue comes from the investment community.

While the Comptroller is the statutory custodian, he has contracted out almost all of its functions. The Comptroller has even turned over the the pension payroll operations to FISA, another city agency. There really isn't much left of the old Comptroller's Office. Ed Koch really did out maneuver Jay Golden.

The Trustees should set the target for total fee expenses at 10 basis points. That would have saved $130M in FY-2014 ($184M-$54M). The Trustees could then focus on a basic Russell-3000 US stock index fund & core investment grade bond Portfolio. Maybe the bonds could be indexed also. This will make running the portfolio and hiring staff much simpler.

Note: As of June 30, 2014 NYCERS had $11.8B in US equity index funds with annual fees of $500,000 for FY-2014 with an annual rate of return of approximately 24.5% gross of fees. But at 0.4 basis points the fees don't really effect returns. Yes, that is correct. NYCERS only paid a 0.4 basis point, not even half a basis point for that return. You can see why investment managers get nervous when you talk indexing.

The Trustees can then drop all the garbage asset classes listed below. This won’t be easy because of the crazy contracts the Comptroller’s office has signed in the past. I consider these contracts illegal because of the secrecy clauses.

Asset Classes to be Dropped:

NYCERS: Unproducive Investment Classes: Values and Fees for FY-2014

Asset Class	Fees Paid	Value as of June 30, 2014	Basis Points
Convertible bonds	$2.1M	$.5B	42
Bank loans	$3.1M	$1.0B	31
Emerging manager- US stocks	$4.4M	$1.0B	44
Emerging managers – Foreign stocks	$.3M	$.05B	60
Emerging managers – US bonds	not reported	$.1B	***
Private equity	$58.0M	$4.0B (guess)	145
Real estate	$20.87M	$2.3B (guess)	90
Infrastructure	not reported	$.02B	***
Hedge funds	$15.5M	$1.9B (guess)	82
Emerging market/active	$9.1M	$2.3B	39
Developed Market equity	$11.8M	$5.4B	22
Junk bonds	$6.9M	$2.1B	33
Opportunistic Fixed	$16.3M	$1.1B	148
Foreign bonds	$.4M	$.3B	13
Active US equity	$14.2M	$5.3B	26
TIP bonds	$1M	$1.5B	7
Subsidy to the Comptroller	$2.3M
Foreign taxes	$8.8M

They Never Get Anything Right

The Comptroller made a big splash yesterday. He finally discovered after nine and half years that the city pension funds are paying high investment fees and getting nothing for it. Hell, it is worse than that. They are losing money.

One thing he hasn't yet discovered is that he can't add. The fees are $3.5B over the last ten years, not $2.B.

For this princely fee, the combined five city funds had an average annual rate of return of 5.68% for the ten years. A simple stock index/core bond return for the ten years was 6.59%. That difference translates into a loss of $18.8B ($163.3B - $144.5B)

So what is the Comptroller going to do about it? Not a damn thing. Of course, he could go public with all the secret investment contracts and and the cash flow histories of all the terminated alternative investments. The newspapers would have field day with that.

Where are all the brilliant trustees?

One of the absolute laws of nature is: Never trust anyone, especially with your money.

For the record, here are the fees for the last ten years:

• 2014: $522M
• 2013: $473M
• 2012: $370M
• 2011: $396M
• 2010: $427M
• 2009: $339M
• 2008: $310M
• 2007: $262M
• 2006: $193M
• 2005: $158M

Another point of confusion is the total value of the five city pension funds. As of June 30, 2014 is was $144.5B, not $175.4B. You don't include the $32.9B that is in the teacher's TDA fund and the police & fire VSF funds. This money does not cover any pension liabilities.

The Comptroller's Office and Simple Arithmetic

NYCERS released its FY-2014 Comprehensive Annual Financial Report (CAFR) on Jan. 1, 2105. This report is submitted to the GFOA every year and is supposed to be a standardized financial report for all state and local government entities in the US. In addition, it is supposed to provide information to the general public, especially to actual and potential lenders, about the entity’s financial health and the level of risk involved with lending to the entity.

There is a significant section in the NYCERS CAFR dealing with investment details that are prepared by the NYC Comptroller’s Office. This is the first report produced by the current Comptroller. In this section on page 114 is a chart of the rates of return for the total portfolio and the major assets classes within the portfolio covering the three years 2012, 2013, 2014. There are also 3 year, 5 year, and 10 year averages. The chart alleges that the rate of return for the NYCERS portfolio for FY-2014 was 17.04% compared to a benchmark of 16.81%. There is no supporting documentation for this number but a reasonable person would conclude that it is accurate.

The audited income statement in the CAFR (page 82), however, tells another story. Based on numbers in the income statement which were signed off by the outside CPA firm, the opening balance for the NYCERS portfolio on 7/1/2013 was $47,194.6M and the closing balance as of 6/30/2014 was $54,422.0M. The income statement also indicates that NYCERS had a positive cash flow of $691.0M in FY-2014. Based on these numbers NYCERS had a total rate of return of 13.85% in FY-2014, (($54,422.0 - $691)/ $47,194)-1).

This same pattern has been occurring, at least, as far back as 2010 as you can see from the figures below drawn from prior CAFR’s:

• - Year: Reported vs Actual
• - 2014: 17.04% vs 13.85%
• - 2013: 12.24% vs 8.81%
• - 2012: 1.32% vs -1.14%
• - 2011: 23.12% vs 19.39%
• - 2010: 14.09% vs 10.68%

The other figures quoted in this schedule on page 114 are much more difficult to compute and I have no confidence that the Comptroller was any more successful with the math for these numbers. In particular, he quoted 15.2% rate of return for NYCERS’s private equity contracts. I suppose he is referring to the eight contracts that terminated in FY-2014. Of course, you might easily be misled and think that he was referring to the entire class. That would wrong and he is very carefully never to report rates of return for open contracts.

But let’s get back to 15.2%. Of the eight contracts that closed in FY-2014, either by exiting or sale on the secondary market, the Comptroller is not providing any cash flow histories for these contracts. Not only do I think the 15.2% is incorrect but I think the rate of return on these closed contracts showed a loss like the Allegra contract. If I am wrong, all we need is the cash flow histories on the eight contracts to compute their correct rates of return. If I am right, you will never see their cash flow histories.

What makes this more outrageous is that over the last 15 years, members of NYCERS have contributed $5.4B out of their own paychecks into NYCERS along with $21.8B of taxpayers’ money that has also been contributed. Oh, I forgot. Members are taxpayers too.

If the Comptroller’s Office cannot perform simple arithmetic, then the NYCERS Board of Trustees has a serious problem with renewing its annual delegation of investment authority to the Comptroller.

The fact that the rates of return are consistently inflated raises the suspicion that it was done on purpose. The investment figures are not audited. NYCERS actual average annual rate of return over the last 15 years is 2.89%, a little scary.